Why are foreign banks expanding in China despite weakening profitability?
Although foreign banks in China have lagged behind domestic lenders in key profitability indicators over the past two years, the growth potential of wealth management and cross-border financing in the world’s second-largest economy may explain why. they remain or even develop.
While net interest margins tend to decline for most banks in China under Beijing’s accommodative monetary policies, foreign lenders have seen their yields on loans and other interest-bearing assets fall more sharply than national institutions. As of March 31, the spread between foreign bank NIMs and the country’s six largest state-backed commercial banks, for example, had widened to 47bp from 26 two years ago, according to the China Commission. banking and insurance regulations.
In addition, the combined net profit of 41 foreign lenders in China fell to 6.0 billion yuan at the end of the first quarter, from 7.6 billion yuan a year ago, according to the CBIRC. It was 0.98% of net profit for all banks in China, up from 1.27% a year ago. This contrasts with the large commercial banks, which reported a 2.76% year-over-year increase in their combined net profit, with their share of total industry profit edging up to 51.57% from 51.37%.
“The gap reflects the structural trend that foreign banks are not as competitive and efficient as large [Chinese] commercial banks. [But China’s] market is still attractive given the potential size and the net interest margin may still be greater than [their] domestic markets, ”said Gary Ng, Hong Kong-based economist at Natixis investment bank.
“The presence on land [in China] is important for customer relations and offshore or cross-border financing, which may be even more relevant for foreign banks at this stage, ”he added.
Despite chronic comparative disadvantages due in part to the dominance and scale of local players as well as the emergence of fintech platforms, many foreign lenders continue to grow in China organically or through acquisitions. . Even a small part of China’s banking sector, experts say, could help foreign lenders, as many of their key markets such as the United States and Europe struggled to grow even before the pandemic.
Among the latest deals, Singaporean company DBS Group Holdings Ltd. acquired 13% of Shenzhen Rural Commercial Bank Co. Ltd. in April. HSBC Holdings PLC, Standard Chartered PLC and Citigroup Inc. also announced earlier that they would strengthen their wealth management operations in China by targeting the growing middle class.
HSBC, for example, recruited 100 wealth planners in mainland China in the first quarter, out of 600 new hires planned in Asia. The bank said its commercial loans in Asia increased by $ 3 billion in the first quarter, mainly thanks to mainland China and Hong Kong.
One of the reasons foreign banks in China are less profitable than their domestic counterparts is their consistently high cost of funding, a key component of NIM.
The retail networks of foreign banks in China are much smaller than local players, who can rely on low-cost deposits as their primary source of funding. Seeking wholesale financing on the interbank market, the price of which is set by reference to interbank rates generally higher than deposit rates, or the fact of attracting more deposits by offering interest rates higher than those of the market add to the pressure on already declining NIMs for foreign institutions in China.
Cao Zhu, analyst with Shenzhen-based Guotai Junan brokerage firm, added that China’s removal of restrictions on bond market and money market interest rates in recent years has contributed to the NIM’s faster decline. for foreign banks and other lenders with a smaller deposit base.
“The interest rate fluctuates within a wider range as it liberalizes, which also makes it more expensive for banks to absorb deposits and borrow in the financial market. However, lenders with more branches are generally less affected because they have more deposits on hand and more ability to attract customers, ”Zhu said.
The Shanghai Overnight Interbank Offered Rate, or Shibor, rose to 2.187% on June 1, from 0.899% at the start of 2021, according to the China Foreign Exchange Trade System and the Nation Interbank Funding Center.
Relatively conservative provisioning for bad loans is another reason foreign banks in China are less profitable.
The loan loss allowance coverage ratio of foreign banks, which also takes into account unforeseen losses beyond loan loss allowances that act as buffers against NPLs, is consistently higher than domestic lenders and the minimum regulatory for almost two years. Such a policy has limited the growth of banks’ net interest income, according to Xiong Jinwu, associate professor at the China University of Political Science and Law.
As of March 31, the coverage rate of foreign banks stood at 335.98%, against 285.1% for the same quarter in 2019. It was higher than the 219.56% declared by the six largest public banks in the first trimester.
“This shows that foreign banks are more cautious in terms of risk management. However, they will have to strike a balance between building sufficient reserves and profitability,” Xiong said.
Ng added, however, that the higher provision coverage ratio for foreign banks reflects the limited tools available to them to cede nonperforming loans. Unlike domestic lenders, only a handful of foreign banks are allowed to securitize bad loans in order to wipe distressed debt off their books.
What NIMs fail to capture, however, is the performance of paid businesses, such as mutual funds and stock brokerage, which have improved for some foreign banks in recent years.
HSBC’s net commission income from mainland China, for example, increased 38.9% year-on-year to $ 120 million in the first quarter of 2021, while interest income grew only d ‘about 0.75% to reach $ 401 million in the same period. Interest income represents approximately 45.6% of HSBC’s income in China.
Morningstar’s senior equity analyst Michael Wu also said foreign banks will focus on cross-border transactions to differentiate themselves from local banks since they have branches overseas. This aspect may become increasingly important in the future, as more and more Chinese companies may seek listings or acquisitions abroad.
“Compared to Chinese counterparts, foreign banks generally have a larger global presence with a stronger connection in international capital flows. Such benefits would enable foreign banks to play a vital role in opening up China’s financing by facilitating two-way capital flows, such as bringing foreign investors to China and back again, ”Ng said.
Morningstar’s Wu added that even Chinese banks are target customers for foreign banks. “Singaporean banks, for example, could lend Singaporean dollars to Chinese banks,” he said.
Besides institutions, high net worth clients may also be the target as they are more likely to have a demand for cross border and wealth management services, which foreign banks have more experience. “It can be competitive, but the overall pie is growing at a pretty solid rate,” Wu said.
As of June 2, US $ 1 was equivalent to 6.38 yuan.